“For private equity funds, the clock starts ticking the second you sign, the second you own your new portfolio company. So the Holy Grail is: how do you add superior value?” That’s how InterimExecs CEO Robert Jordan helped kick off a recent panel about adding value to portfolio companies. Sponsored by InterimExecs and hosted by Private Equity Career News publisher David Toll and John McNulty’s Private Equity Professional, panel experts shared best practices for value creation.
On the panel were Jordan, Micah Dawson, vice president of Portfolio Support at Trivest Partners; Pericles Mazarakis, managing partner of TriSpan; and Mike Zawalski, an InterimExecs RED Team member who serves in executive chairman roles with PE-backed portfolio companies.
Here, we round up the top insights from the panelists, everything from the importance of monthly operation reports to establishing trust with the business owner and investing in human capital.
Outline Your Playbook
In the heyday of LBOs (leveraged buyout funds) 30 years ago, fund managers attributed the majority of their ability to create value to leverage, in some cases to ridiculous levels. In the current PE world, things have changed. Operational improvement now accounts for the majority of added value, with debt and leverage far less important in the overall equation. And being nimble operationally stems from a roadmap—a 100-day planner that ensures all partners and managers can hit the ground running from day one.
“I strongly believe that all sponsors should have a playbook from the conception of the investment thesis all the way through to exit,” Zawalski says. “It absolutely is vital to make expectations clear between the executive team running your portfolio company, the board and the operating partners. When done well, it can really enhance value. Once you have that clearly identified, you build your operating model, management team and everything around those things.”
Zawalski points to six basic components of the playbook:
- Strategic plan: Determine your business’ position in the marketplace, establish how you’ll build externally focused value and how you’ll win—and make sure to circle back on it annually to reflect advances over the years relative to that initial investment thesis.
- Operating budget: It’s less about the finance team putting together departmental expenses and getting a gauge from the sales team on revenue. Instead, focus on a commercial-based annual operating plan and budget. With a customer-centric view, think about how the business model may change based on your position in the marketplace, product innovation, culture and your leadership team. Financials come after all that, Zawalski says.
- Performance management: Streamlining performance means aligning how you run your business with the strategy outlined in the investment thesis. This comes down to evaluating everyone—from the CEO down—against the same standards of leadership capability, achievements, objectives and cultural values. It also includes clear alignment around compensation.
- Monthly operating and financial report: Like Jordan, Zawalski emphasizes the importance of operations first, financials second. “Financial statements confirm that the strategy and operating model is adding value to customers and therefore adding value to the business. To me the operating aspects of the business go first.”
- 13-week cash flow report: Contrary to its name, a cash flow report isn’t just about maximizing available cash to invest in the business and create greater value capability. A robust report can actually be an insightful window into operational excellence, too.
- KPI stack: Don’t get bogged down with the number of pages. A clear, one-page KPI stack makes it clear to the management team and sponsor what truly drives value and what the key metrics are to identify areas of opportunity and how you’re performing against your plan.
While there’s plenty more that can be outlined from the get-go—including standardizing the onboarding and exit processes and streamlining communications so everyone is on the same page—as Jordan explains, this takes time.
“There’s an immersion period,” he says. “A lot of people would love to believe that’s going to be faster than nine months, which would be great. But in fact, change is hard. And so in a lot of cases it’s a nine- to 18-month process with consolidation and improvement.”
When it comes to low-hanging fruit, pricing—as in, price elasticity, pricing opportunities, and the price value relationship of the product or service—should always be an early part of due diligence.
“Price is what somebody is willing to pay for your product or service and helps inform value proposition, marketing strategy, and other things you may change early on in the life cycle of your portfolio company,” Zawalski says. “Certainly when I’m doing due diligence, pricing gets to be in the muscle memory of a portfolio company.”
And those conversations surrounding price inevitably fold in cost-saving opportunities, the second lever to manage in ensuring healthy returns.
“On the cost side, the main opportunity is around purchasing and outsourcing,” Mazarakis says. “Depending on the size, it’s also consolidating offices or manufacturing plants that don’t have optimal capacity, and making sure you can consolidate those practices into fewer, better and more efficient operations.”
Put yourself in the shoes of the acquired company—the process can be daunting to a founder, particularly in a family-led business. Dawson says it’s worth identifying a few items that you can relinquish in the name of building trust, like submitting an LOI and structuring deals without earnouts or re-trading.
“Establishing that foundation of trust is the cornerstone of creating value once the partnership has started,” he says. “The best definition of leadership I’ve heard is: convincing someone to do something that they wouldn’t do on their own. In the lower middle market, there is not often much bench strength. Telling people, ‘You’ve got to do this and if you don’t, we’re going to take away that’—I don’t see that as a winning strategy to drive value.”
Dawson explains that while Trivest started like most private equity firms—with a standard buyout fund that takes control stakes—they found that many owners weren’t ready to hand over that control. Their solution? Buying 25% in order to prove how their playbook could create value and prepare the business for the possibility of a complete exit.
“We tend to get involved with companies who are founder-led,” Dawson says, “they haven’t really built an infrastructure, they don’t have budgets, KPIs. They’re not running the business in a way that normally you would say enables you to scale the business significantly. So the more that you can actually show the best practices in the industry that enable you to scale up the business, to put guardrails and professionalism that will drive better decision-making and make it much more systematic—I think they react very positively to that because they know it’s a skillset that they don’t have themselves.”
But establishing trust and leaning into the budding business relationship can also be as simple as asking questions. Go in with the mindset that you’re there to learn rather than bulldoze into someone’s business.
“I’ve always found that asking really insightful questions thaws that initial trust conflict that exists particularly with founders,” Zawalski says. “Lead with questions—not coming in and saying, ‘Hey, when I was at Quaker Oats, we did this, when I was over here, we did that.’ Learn about the business, get out in the field, in the plants, get with the product development team—whatever it is, show that interest and level of enthusiasm to get that foundation built first.”
Prioritize Human Capital
The saying goes, “It’s who not how,” and the same can be applied for how private equity funds drive value.
“To me, the biggest lesson, particularly in the lower middle market, is it’s much better to have a good management team with an okay business model than to have a great business model with a bad management team,” Mazarakis says.
Sometimes that may mean supplementing your team with an interim operator or C-suite executive who comes with a specific skillset or personality that can feel like the missing puzzle piece.
“You have all of these tools and frameworks,” Jordan says, “but they’re only as good as the operating executive in whose hands they’re being accomplished.”
One of the most successful value creation scenarios Dawson has seen involved this kind of pinch-hitter tactic. They were pushing towards exit for a business and knew there were a handful of previously unsuccessful initiatives that had accounted for several million dollars in EBITDA. Even with a plan in place and knowing exactly where the money was, they couldn’t convince the management team to go after it.
“We were able to crack the code by finding someone with a good bedside manner, the talent who could go in and then get these things done for us and was able to create about $3 million in EBITDA in the course of four months heading into the sale,” he explains. “On the exit multiple we realized that it was substantial value creation—tens of millions of dollars.”
Ensuring you have the best operating executives can serve as a sanity check on not just the particulars, but also on big-picture goals, trends, themes and evaluation of the management team.
That was what unfolded for Dawson with a dental roll up that started as nine sites and expanded to 79 locations. By way of a strong M&A approach, they captured smaller, independent dental offices and strengthened the human resources side of the equation. A game-changing part of that meant hiring an operating partner who had replicated this successfully at a previous firm and had the playbook for a post-merger integration. He also happened to be a dentist, and could speak the language with the founder and the chief dental officers.
“He developed a clear playbook on replicable integration, value creation and optimizing costs, particularly as it comes to integrating a lot of different businesses,” Dawson says. That included transforming the business from exclusively Medicaid to a mix of Medicaid and PPO for a more reliable cash flow and broadening it from a generalist dentistry operation to a specialist operation to leverage the expertise. This resulted in five acquisitions over two years and taking advantage of accretive acquisitions in a very fragmented market to eventually create one high-value brand.
An added bonus of effective, well-trained operating partners is having built-in role models for the rest of your team.
“One of the most subtle value creators between a sponsor and management team are the behaviors of the board members in that management meeting,” Zawalski says. “The interaction points give your management team permission to do or not do certain things. It also manifests itself in small ways. If you’re late to every meeting, you give them permission to be late. If you don’t like profanity, and you use profanity, they’re going to use profanity. The behavior that you exhibit is vital. Be role models for your portfolio companies.”
*You can view the recorded webinar here.
InterimExecs RED Team is an elite group of CEOs, CFOs, CIOs, and CISOs who help organizations through turnaround, growth (merger, acquisitions, ERP/CRM implementation, process improvement), or absence of leadership. Learn more about InterimExecs RED Team at www.interimexecs.com/red-team or call +1 (847) 849-2800.